Best Buy's Earnings: Still Facing Showrooming And Product Mix Challenges

Electronics retailing giant Best Buy will announce its Q3 results on November 20. The company has been in news in the last few months for a number of reasons. It appointed Hubert Joly as the new CEO of the company and Sharon McCollam as the new Chief Administrative Officer as well as the CFO. Also, some leadership responsibilities were redistributed and the organizational structure itself was changed.

All through the quarter, there was constant speculation as to whether Richard Schulze, the founder of the company, would place a bid to take it private. Showrooming and changing customer preferences continued to be major factors for the electronics retail chain.

On October 24, Best Buy provided an update on its expected results for the third quarter. It said that comparable store sales are expected to decline at a rate consistent with the range of results for the first two quarters. Comparable store sales had declined by 5.3% in the first quarter and 3.2% in the second quarter. The company also expects gross profit rate to decline at a rate similar to that experienced last quarter, owing to investments in new product launches. SG&A expense percentage growth is expected to be in the low single digits over the prior-year period due to increased expenses on training of employees and higher compensation costs. In addition to all this, during interaction with analysts and investors earlier this week, the management made no mention of the quarter’s results. According to us, the overall picture for the quarter’s results is not good. We won’t be surprised at a slight drop in revenues and a weak Q4 guidance.

The following factors will have an impact on Best Buy’s earnings results:

1) Showrooming

Best Buy’s stores are becoming less profitable as customers increasingly use them to browse for electronics, then buy them cheaper online or elsewhere. CEO Hubert Joly has decided to tackle the problem of showrooming head-on.

Best Buy now intends to convert people who come into stores to “showroom” into buyers through better customer service for which it is spending more on employee training. It has also announced that it will match the lower prices offered by Amazon and other online retailers in its brick-and-mortar stores during the holiday shopping rush from November 27, to December 24. ((Best Buy to match some rivals’ online pricing, Yahoo News)) Best Buy is simultaneously trying hard to sell its products online and investing in building a strong internal IT team over the next few months.

All of these initiatives are clearly meant for the future and the effect will be felt only in Q4 and next year.

2) Changing Product Mix

Shoppers are no longer snapping up as many TVs and desktop computers which are more profitable. They are instead opting for gadgets like cellphones and tablets which are less profitable for Best Buy. The proportion of mobile and computing in revenues in the domestic segment increased to 44% (from 40% in Q2 2012) whereas that of consumer electronics shrunk to 33% (from 36% in Q2 2012) for the company.

TV’s still constitute a major portion of its sales but average selling price has been falling even though the number of units sold are rising. This is due to higher contribution of small and mid-sized TV’s to the product mix. TV’s and PC’s come with high-margin yielding warranty and service attachments so lower sales hurt margins.

While the company remains the top U.S. seller for tablets, Windows and Apple notebooks, and its share of smartphone sales increased by 50% last year, empirical evidence from previous quarters’ results suggests that the higher volumes have failed to compensate for lower margins thus far. Tablets and smartphones do provide opportunities for high margins on warranties, service contracts, and accessories, but we think that it will take time for Best Buy to monetize these at the same level as TV’s and PC’s. Third quarter results are unlikely to reflect sizable gains on this front.

3) Expansion of Geek Squad’s Services

In a bid to open a new stream of revenues, Best Buy has partnered with eBay and Target to offer its popular Geek Squad services. eBay has added service plans on its website for customers wishing to gain from the Geek Squad’s services while trials are also being conducted at some Target stores in Denver and Minneapolis.

The Geek Squad division already earns over $1 billion in revenues for the company and diversification represents a major business opportunity. We will be keen to know how many eBay and Target customers have opted for the Geek Squad’s services so far.

In addition, we will look out for any updates on a possible offer from Richard Shulze to buy the company and the management’s comments on plans for the holiday season. The holiday period is crucial since retailers can earn up to 40% of their annual revenues during the period.

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